The decision to invest using an ESG prism or to attempt to mitigate the climate risk of one’s portfolio may be fraught with biases that are not necessarily borne by the investor.. This choice often leads to overweighting (or underweighting) geographies, sectors, or even company types, and this can have a very real impact on performance. Nothing is serious when these biases allow you to perform above the rating. But it becomes a problem when the characteristics of these values work in opposite ways.
This has recently been the case with growth stocks, which are structurally overrepresented in ESG portfolios, but the rise in interest rates over the past year has led to a sudden realignment in valuation. A similar observation holds for midcap values, generally overrepresented in securities eligible for this type of management, but which have suffered strong outflow movements over several years. For the opposite reason, structurally low ESG stocks, such as energy, performed comparatively well over the same period. In short, the cyclicality of investment biases creates additional volatility and risk that risks driving some investors away from ESG management.
ESG or climate indicators simply reproduce these biases
However, are investors forced to choose between financial and extra-financial? Not necessary. One way is to measure these biases, then correct for them by weighting the best students from structurally underrepresented fields or genres. This makes it possible to create an ESG or climate factor, depending on the desired objective, which is pure and independent of other risks. It allows portfolios to approximate the characteristics of major market indices while limiting style and sector deviations.. These potential corrective values remain to be identified, i.e. those that offer an attractive additional financial profile and a complementary financial profile to “classic” ESG champions. The profile of companies evolves over time but in the past companies such as Johnson Controls, CVS Health, General Mills or even Owens Corning have been able to make a real positive contribution to ISR management in difficult periods, often being overvalued and less visible. Expected growth rate.
This portfolio construction logic allows the investor to obtain a portfolio with ESG and/or climate characteristics that outperform the market as a whole.
Given the increasing cyclicality of the performance gap between the most durable and average rated stocks, such an approach seems relevant to broadening the development of SRI management.
